FX: Don’t be fooled by gold’s blistering 2016 start

With rates near their lower-bound or hovering in negative territory around the developed world, the opportunity cost of investing in gold – which critics decry for lacking a regular income stream – has essentially vanished. Unless the fear continues to rage, the commodity’s recent spell should run out of steam as US rates creep up.

The year to date has been characterized by heightened risk
aversion and panic, interspersed with relatively few periods of
optimism.

And while Japan became the latest country offering negative
interest rates on central-bank deposits this month, gold was
surging: it has risen around 17% from the start of the year to
its peak of around $1,260 in 2016.

Robin Bhar, metals analyst at Société
Générale, says: "In recent weeks, we have seen a
lot of concern about currency devaluation and further
central-bank easing and that was a perfect storm for gold."

Adrian Ash, head of research at BullionVault, says:
"Negative deposit rates in the eurozone and Japan are now
approaching commercial storage charges on physical bullion,
while Swiss Libor and the Swedish Riksbank’s
deposit rate already exceed even the higher fees of gold-backed
exchange traded funds (ETFs)."

The cheapest major ETF is the iShares Gold Trust, says Ash,
which charges 0.25% per annum, while the biggest gold ETF is
the iShares SPDR, which costs 0.40%.

Joni Teves, precious metals strategist at UBS, says:
"Gold’s cost of carry has been an argument against
holding it, so negative interest rates in a sense evens out the
playing field.

"For monetary policy easing outside the US, the near-term
reaction function could be muddled by currency moves versus the
dollar, but in the long run, easing should be positive for
gold."

For now the impact of negative rates on gold are relatively
modest because the costs are being absorbed by the banks, and
have not yet been passed on to the public. However, the impact
of negative rates will increase should the banks pass the cost
on to consumers, says Teves.

Yet despite the falling costs of
investing in gold, its investment case remains polarizing.
The metal has seen strong moves in recent months amid market
volatility and risk aversion since the start of the year, but
many analysts believe that trend has now run its course.

SocGén’s Bhar says: "The US economy is
looking pretty healthy given recent jobs data making rate rises
more likely, even if we have to wait until 2H. At the very
least, that is likely to cap gold performance, but more likely
it is going to drive it down."

UBS agrees gold is unlikely to continue its recent surge,
predicting prices will stabilize and average $1,225 this
year.

However, gold might look more attractive to non-dollar
investors, especially for currencies that are weakening against
the dollar.

"If we see the Bank of Japan or European Central Bank
easing, gold may look attractive when purchased in yen or
euros," says Bhar.

Therefore, the case for holding gold often centres on
diversification, and in some cases a lack of trust in the
financial system itself. Although it pays no interest, its
advocates argue it offers protection from inflationary,
super-loose monetary policy that erodes the value of fiat
currencies.

The perception of gold as a superior store of value to
national currencies is at the heart of its appeal to many
investors.

BullionVault’s Ash says: "Die-hard gold
investors never trust the fiat money system. Central bankers
make gold bugs of us all when they try desperate experiments to
claim some pretence of control over the economy or
markets."

Yet gold’s worth as a store in value depends on
the timeframe under consideration. It is clearly as capable of
losing value as any fiat currency, regardless of central
bankers’ inability to print more of the metal, as
evidenced by its performance in the 1980s and 90s.

Because gold has only floated since 1971, there
isn’t sufficient data out there to make a
definitive case about gold’s performance as a
store of value, relative to fiat currencies.

What is clear is that gold is sensitive to changes in
interest rates – though more to the real
inflation-adjusted rate than the nominal rate, and more to the
direction of travel than the absolute level, says Ash.

Further reading on Euromoney

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